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What to Expect in Latin America?

5 MIN READ•May 19, 2020

In the same week that our members were supposed to gather in New York City for the annual conference Infra Latam GRI, we joined the online eMeeting to discuss how Latin America will look like in the near future along with James McCormack, Global Head of Sovereign Ratings at Fitch Ratings. The subject could not be more appropriate as we are experiencing one of the worst crises of our lifetime.

We began by analyzing how the global economy might perform in the next years and the prospects for long-term growth, which is one of the keys to unlocking infrastructure investments. Fitch Ratings’ methodology evaluates three main characteristics when building prospective scenarios: Policy convergence (policy cooperation and alignment has given way to policy convergence, short-term objectives are clear, medium-term risks are real); Developed markets (fiscal deteriorations everywhere, uncertain fiscal space and growing debts); and Emerging markets (also facing fiscal challenges, lower commodity prices, sudden stop in capital flows and money moving out of emerging markets, currency depreciation). According to McCormack, the aspects mentioned for emerging markets are considered the classic recipe for crises in those countries.

Fitch rates 119 countries at the moment and 31 of them have a negative outlook, which is considered to be a bad scenario. In the history of sovereign ratings, the agency has never had this amount of countries with negative outlook at the same time. The majority of those countries are located in Latin America, Middle East and North Africa. Even in comparison with past years, the three regions did not show net positive outlooks. Not coincidentally, the regions are the most dependable on commodities and suffered the heaviest currency pressure.

Concerning 2020, Fitch rates sovereign states as the lowest downgrade outlooks in history (there have already been 28 downgrades this year and only 3 upgrades, that is also a record since the agency started rating sovereign states). Again, this group consists mostly of Latin American, African and Middle Eastern countries. The most common grade was B and the lowest, including with default rates, were C and D. That shows that weak economies are getting weaker. The last year where Latin America had more upgrades than downgrades was in 2013.

One of the most common issues for emerging markets at the moment, according to Fitch Ratings, is that interest rates were cut across the region, helped by lower inflation and other interest rate cuts globally. However, exchange rates depreciation might raise inflation. One positive aspect comes from the country's external finances, which are relatively in a stronger starting position compared to past global financial crises. Political issues are also under the spotlight as many sovereign states have experienced social unrest (Bolivia, Chile, Colombia, Ecuador, Nicaragua), governability crisis (Brazil, Peru, Central America) and reform uncertainty (Brazil, Mexico, Argentina).

At the same time, regions that heavily depend on commodities can economically grow when prices are high, while the opposite can damage those economies. LatAm countries are the second most commodities dependable countries in the world (hard currency external earnings from exports / GDP), only behind Sub Saharan states. Another pressing issue is the total US dollars being borrowed from the private sector, which revealed that LatAm is on a fast paced increasing ratio of debts/revenues. Concluding the first part of the presentation, government debts are also increasing and are strongly deteriorating fiscal conditions. The LatAm region has an average of 10 percent over GDPs as government debt. For instance, Brazil averages at 13.5 percent, while Chile 11.3 percent and Argentina 8.6 percent.

Demographics

Experts established that demographics are one of the keys to predict long-term growth performance. In the past 40 years, almost all countries had their population growing at 2 percent per year minimum. The forecast for the next 40 years is that all countries in the region will not see population growth over 1 percent per year. Those numbers show that there is a big change coming in terms of long-term growth for Latin America.

In demographics projections in the next 40 years, the scenario for LatAm shows that economies will grow an average of 2 percent during this period, with some countries with lower rates and others with a higher growth. The only two regions that have a better demographic outlook are the Middle East and Sub Saharan Africa. India, for its turn, also has a positive perspective considering demographics.

Defaults

Since 2000, when Fitch started rating sovereigns, the world has seen 23 defaults. Out of the three default economies in 2020, two of them were in Latin America: Argentina and Ecuador (the third is in the Middle East, Lebanon). "Never before have three countries defaulted in just one year, and we are still in May. Other countries are in CCC condition, so we expect a higher number than that", said McCormack.

What is the infrastructure investment forecast for 2020?

As per the conversations between Fitch Ratings and political leaders across the globe, infrastructure is usually not an immediate priority. Urgency measures are mostly taken considering healthcare, safety, employment support programs and financial aid to companies in order to keep workers paid. Thus, CAPEX spending for infrastructure in the short term will rather be lower than higher. Afterwards, when the worst part of the crisis is gone and countries start to move ahead, then economies and investors probably will look more robustly for infrastructure investments. As one of the most important global players for infrastructure, China and its Communist Party Congress, will surely announce meaningful measures on May 22 and the rest of the world might follow through.

The path to recovery

Further analyzing China, the rating agency stated that there will be virtually no growth for the Asian country’s economy, but important measures to boost it are in the making. As possible downturns, Fitch Ratings considers that a second wave of COVID-19 spreading can slow its recovery, along with decreased external demand.

Rather than a V-shaped recovery, Fitch estimates that this recovery will come gradually. Even during that gradual recovery period, when quarter grades are analyzed they might look in good shape, but if the approach is year-on-year growth rates they are still going to look quite poor. A key factor for a slower recovery would be the fact that incomes throughout the world are at lower levels, which can persist until the end of 2022.

Regarding Mexico, Fitch Ratings recently downgraded its rating to 'BBB-' from 'BBB'. One of the main challenges ahead is to consolidate public finances once the crisis is over and return debt/GDP to a sustainable path. At the same time, monetary policy framework built upon a flexible exchange rate and inflation targeting are strengths that can help the economy to absorb effects of the coronavirus crisis. A second hit, however, may come from falling oil prices. As Mexico is a very important economy for many Central American and Caribbean countries, financial contagion used to be a crucial concern. However, now global investors are managing to differentiate one country from the other and are more accurately putting into place their resources.

In April, the G20 urged private creditors to take part in its plan to provide temporary debt relief to developing countries until the end of the year. Those resources are expected to be used for healthcare and urgent needs by severely affected economies. Ecuador and Zambia were already forced to seek debt restructurings, and others are expected to follow given the economic crisis.

Finally, McCormack spoke about currency depreciation in Latin America. This type of measure is heavily present in Latin America and is adopted due to regional economic structures, mainly connected to the dependency on agricultural and mineral commodities. Some Central Banks can even raise interest rates to prevent capital flowing out of the market, which can deepen the struggling situation that the economy is already facing. Another common measure in the region is defending the currency through intervening in the foreign exchange market.

The downturn is being forced to spend substantial amounts of FX reserves. In the case of Latin American, there is still room for arguing. When the global commodities price correction took place two years ago, adjustments in Latin America were more on the currency side. Central Banks stepped back and allowed exchange rates to make those necessary adjustments. In other parts of the world, commodities' exporting countries also tried to hang on to their exchange rates (to prevent depreciation), heavily spent external FX reserves and still ended up with depreciation and a weaker Central Bank balance sheet.